Signaling Through Private Equity Placements and its Impact on the Valuation of Biotechnology Firms

Posted: 24 Nov 2009

See all articles by Jay Janney

Jay Janney

University of Dayton - Department of Management

Timothy B. Folta

Purdue University - Krannert School of Management

Date Written: 2000

Abstract

An important aspect of young firms' competitionis their ability to attract resources that allow them to commercialize theirideas. As many public firms, especially in high-technology industries, havehard-to-value assets, it is important that firms continue to show knowledge oftheir growth to prospective investors in order to prevent informationasymmetry. It is argued that publicly-held firms signal their value toprospective investors by their choice of issuing private equity vs. publicequity. Firms issuing private equity signal the marketplace that managersbelieve their growth opportunities are undervalued. Signaling effects are approximated by measuring the biotechnology firm’sabnormal returns following private placement. Abnormal returns are calculatedfor 695 private placements. The empirical data demonstrate consistent effectsfor the influence of strategic signals on the valuation of new ventures. Thefindings suggest that the timing of prior signaling events, the number of priorsignaling events, and the building of alliances with private equitytransactions strengthen the current private equity signal. The analysisconfirms the initial hypothesis that frequent signaling reduces the growth ofinformation asymmetry. A theory suggesting that returns are determined by thetiming of previous signals is proposed. It is concluded that for firms that are not yet self-sufficient, signalingtheir value is important for attracting resources to commercialize promisingideas. Also, although capital is a commodity, the process by which capital israised is not a commodity, and it can offer ways for crediblesignaling.(CBS)

Keywords: Signals, Equity investments, Investment decisions, Biotechnology industry, Valuation, Information asymmetry, Private equity, Firm financing, Capital

Suggested Citation

Janney, Jay and Folta, Timothy B., Signaling Through Private Equity Placements and its Impact on the Valuation of Biotechnology Firms (2000). Journal of Business Venturing, Vol. 18, Issue 3, 361-380 2000. Available at SSRN: https://ssrn.com/abstract=1510590

Jay Janney (Contact Author)

University of Dayton - Department of Management ( email )

United States

Timothy B. Folta

Purdue University - Krannert School of Management ( email )

1310 Krannert Building
West Lafayette, IN 47907-1310
United States
765-494-9252 (Phone)

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